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Yesterday legislation was introduced into Parliament to require purchasers of new residential premises and “potential residential land” to withhold an amount from vendors and to pay the amount directly to the ATO at or before settlement. The legislation takes effect from 1 July 2018.

A media release by the Minister for Revenue and Financial Services (here) states that the changes will prevent tax evasion by unscrupulous property developers that fail to remit the GST on sales of new residential premises and new subdivisions, despite having claimed GST on construction costs.

An Exposure Draft of the legislation was introduced on 6 November 2017 and my discussion of the draft can be accessed here.

The amendments are to be introduced into Schedule 1 of the Taxation Administration Act 1953 as an extension of the withholding provisions in Division 14. These provisions require a payer to withhold part of monies payable to another person in certain circumstances and to pay those amounts to the ATO – for example PAYG withholding.

S 14-250(1) and (2) – The withholding obligations will apply to the supply of:

“new residential premises” – other than premises have been created through substantial renovations of a building and commercial residential premises; and

“potential residential land” which is defined as “land that it is permissible to use for residential purposes, but does not contain any buildings that are *residential premises” – other than land which contains any building that is in use for a commercial purpose.

For the sale of “potential residential land”, the withholding obligation only arises if the purchaser is not registered for GST or does not acquire it for a creditable purpose.

S 14-250(6)-(7) – The purchaser must pay to the Commissioner an amount equal to 1/11th of the “price” for the supply, but where the margin scheme applies 7% of the “price” must be withheld – although the Minister may determine a higher percentage but not exceeding 9%. Where the contract of sale specifies an amount as the “contract price”, that is the price to be used.

S 14-250(4) – The amount must be paid on or before the day on which any of the consideration for the supply (other than as a deposit) is first provided. This will usually be at settlement, but for a contract payable by instalments, the obligation will be triggered at the time of payment of the first instalment (not being the deposit).

S 14-250(11) – Where there are multiple purchasers, the supply will be treated as separate supplies to each purchaser and each purchaser will be required to withhold the appropriate portion of the price. Purchasers who are joint tenancy are treated as single recipients.

Where the purchaser pays the amount to the Commissioner, the supplier will be entitled to a credit equal to that amount.

Disclosure obligations on the vendor – s 14-255

S 14-255(1) – A supplier must not make a taxable supply of “residential premises” or “potential residential land” to another entity unless, before making the supply, the supplier gives to the other entity a written notice including:

Whether the other entity will be required to make a payment under s 14-250 in relation to the supply.

If so, particular information including the amount required to be paid and when the amount is required to be paid.

A notice will need to be given each time residential premises are supplied as a taxable supply – not just where the supply falls within the amendments. This is to assist purchasers to comply with the legislation.

S 14-255(2) – The notification obligation does not apply to the sale of commercial residential premises or to “potential residential land” to a purchaser who is registered or acquires the land for a creditable purpose.

S 14-255(6) – If the supplier does not give the notice, it is liable to an administrative penalty of 100 penalty units (a penalty unit is currently $210).

S 14-255(3) – The failure of the vendor to comply with the notification obligation under (1) does not affect the purchaser’s obligation to withhold and to pay the Commissioner.

Penalties

If the purchaser does not pay the amount to the Commissioner the purchaser will be liable to a penalty equal to the amount payable – s 16-30 of Schedule 1 to the TAA. However, no penalty will be applied where:

the amount related to the taxable supply of new residential premises and the purchaser reasonably believed the premises not to be new residential premises, the purchaser received a notification stating that the premises were not new residential premises or the notification indicated that no amount was required to be paid to the Commissioner, and at the time consideration was first provided for the supply there was nothing in the contract or any other circumstances that made it unreasonable for the purchaser to believe that the notification was incorrect.

the purchaser gave to the vendor a bank cheque for the amount and made payable to the Commissioner on or before the day consideration was first provided (usually settlement)

Proposed commencement of the amendments

The amendments are to apply to supplies on which any of the consideration (other than the deposit) is first provided on or after 1 July 2018, regardless of the date of the contract of the sale. However, if the contract was entered into before 1 July 2018, the amendments do not apply if consideration (other than the deposit) is first provided before 1 July 2020. Transitional provisions also apply to existing “property development arrangements” .

Tate JA considered the contest to be a narrow one – described as follows:

…whether the inclusion of the letters ‘GST’ in the relevant box, rather than ‘plus GST’, is a sufficient indication that under the contract the risk of liability for GST lay with the purchaser. In other words, does the absence of the preceding single word ‘plus’ in the relevant box preclude the conclusion that the parties agreed to reverse the default allocation of liability for GST by employing the mechanism in general condition 13.1?

Her Honour considered that there was sufficient indication in the contract that the parties agreed to reverse the default allocation of the liability for GST. Her Honour considered the absence of the word “plus” did not preclude that conclusion. Had the parties remained content with the default allocation of liability for GST, there was no need for any words to be added to the box – the box could simply have been left blank. That blank box would have sat alongside all the other blank boxes in the particulars of sale. A reasonable business person would have understood the letters “GST” in the relevant box to mean that the parties, objectively, intended to reverse the default allocation of liability for GST to the vendor and intended to do so by employing the mechanism in general condition 13.1.

Osborn and Kaye JJA came to a similar conclusion. Their Honours were persuaded that: the inclusion of the letters “GST” in the Particulars of Sale; the parties being selective as to which spaces, in those particulars, were filled in; and the commercial context to that notation in the contract, taken together, lead to the conclusion contended for by the vendor – that the risk of liability for GST was to lie with the purchaser.

Any internal legal advice produced by officers of the Australian Taxation Office in relation to the contention by the Respondent that s 38-385 of the A New Tax System (Goods and Services Tax) Act 1999 (Cth) does not apply to the supplies of gold bullion by the Applicant because the supply of that bullion was not the first supply after its refining because the Applicant did not undertake any ‘refining’ to produce the bullion as the refining material from which the gold was produced had a purity of at least 99.5%.

The applicant sought the order pursuant to s 37(2) of the Administrative Tribunal Act whereby the Tribunal can order the decision maker (in this case the Commissioner) to lodge with the Tribunal “documents that may be relevant to the review of the decision by the Tribunal”.

The proceeding involved GST assessments and assessments of administrative penalties that were issued on the basis of recklessness by the applicant. The subject of the GST assessments was the entitlement of the applicant to claim input tax credits in respect of the acquisitions made in respect of the supply of gold bullion- whether those acquisitions were “creditable acquisitions”. Where that supply of gold bullion was GST-free under s 38-385, input tax credits would be available. However, where that supply was input taxed, s 11-15(2)(a) would block any entitlement to input tax credits. The Tribunal observed that the central issue in the substantive proceedings was directed to whether the supply of gold by the applicant was the first supply after it had been refined by the applicant.

The applicant submitted that the Tribunal should be satisfied that legal opinions prepared by internal legal advisors may be relevant to the decision under review. It was put to the Tribunal that the Commissioner had received internal written legal advice to the effect that the position adopted by the applicant was either correct or that the position adopted by the Commissioner was unlikely to be accepted by a court. The applicant contended that if, in making its statements to the Commissioner, a taxpayer adopted a position that is reasonably arguable, it cannot, a priori, have been “reckless” – In the alternative, the applicant contended that whether or not the taxpayer’s position was reasonably arguable was relevant to the consideration of whether a penalty should be remitted.

The Commissioner submitted that any legal advice obtained by him had no relevance to any “taxable fact” with which the proceedings were concerned, that a position may be reasonably arguable but still be reckless, that the request was premature, and that the advice was subject to legal professional privilege.

The Tribunal did not accept the Commissioner’s argument that the application was premature or a fishing expedition. The Tribunal concluded that such internal legal advice produced by officers of the Commissioner go to the issue of whether the applicant’s position is reasonably arguable, which is relevant to the issue of remission of penalties. Further, whether any documents produced are subject to legal professional privilege is a matter to be addressed when documents have been lodged and the question arises whether the Tribunal should direct that they provided to the applicant.

In Decleah Investments Pty Ltd and Anor as Trustee for the PRS Unit Trust and Commissioner of Taxation [2017] AATA 2418 the Tribunal found that the professional valuations obtained by the applicant were not “approved valuations” for the purposes of the margin scheme in Division 75 of the GST Act. The Tribunal found that the only “approved valuation” before it was that provided by the Commissioner, which gave a lower value to the land and resulted in a shortfall of GST for the applicant. The Tribunal also increased the penalties from 25% to 50% on the basis that the applicant’s behaviour was reckless.

The matter involved the sale of lots in a property development in which the Commissioner carried out two audits a number of years apart.

The first audit involved the sale lots by the applicant during the period 1 January 2004 to 31 March 2006. In the course of the audit, the applicant provided three valuations to the Commissioner. The third valuation valued the land at $20,000,000. The Commissioner did not accept any of the valuations as approved valuations and assessments were issued.

The applicant objected to the assessments and proceedings were brought before the Tribunal. The applicant obtained a fourth valuation of $34,000,000 which the Commissioner also rejected. The Commissioner obtained his own valuation of the land of $8,155,000. The matter was settled prior to hearing on the basis of an agreed value of $9,378,250, which equated to $17,051 per lot. The deed of settlement contained the following acknowledgement by the Commissioner:

the valuation of $17,051 per lot sold will not be applicable to tax periods on or after the tax period ended 31 March 2006, unless the taxpayer holds a supporting valuation of the land that complies with the requirements under Division 75 of the GST Act.

The second audit involved sales for subsequent tax periods. The Commissioner concluded that the applicant had not relied on an approved valuation and issued assessments on the basis of a margin determined by reference to the acquisition cost of the property, being $670,000, being $1,192 per lot. The Commissioner also issued penalty assessments at 50% on the basis of recklessness.

The applicant objected to the assessments and provided a fifth valuation of $22,000,000. All of the valuations produced by the applicant were provided by the same professional valuer.

At objection, the Commissioner found that none of the valuations provided by the applicant were approved valuations but partially allowed the objection by increasing the value of the land to $9,378,250, being the value agreed to in the settlement agreement for the previous tax periods. The Commissioner also reduced the penalties from 50% to 25%.

The issue before the Tribunal was whether the applicant held an “approved valuation” – did any of the valuations provided by the applicant’s valuer comply with the requirements in Determination MSV 2005/3 or Determination MSV 2009/1? The Tribunal concluded that the answer was no. The only valuation that complied with those requirements was that produced by the Commissioner.

The Tribunal referred to the following statement of Middleton J in Brady King Pty Ltd v The Commissioner of Taxation (No.2) [2008] FCA 1918 where his Honour said:

The fact that there may be matters of subject analysis undertaken is encompassed and envisaged by the Determination which relies upon a professional valuer undertaking the task and coming to a valuation. However, in reaching the final valuation, the professional valuer must not deviate from the method of valuation dictated by the terms of the Determination.

As the land was acquired by the applicant prior to 1 July 2000, the land was to be valued at 1 July 2000. Both Determinations required that the valuation be done in accordance with professional standards.

The Tribunal observed that the applicant’s valuer had relied on a “discounted cash flow” methodology in the valuations and that his instructions were to perform the value on an as is basis. The valuer understood these instructions referred to actual costs and sales post valuation date. This allowed him to use actual costs and income at the time of making the valuation, which was August 2014. The valuer said that if he had been asked to perform the valuation on an as was basis, he would have been restricted to using only data known or predicted at the valuation date. The valuer’s evidence was that these instructions were taken from his interpretation of a letter provided by the ATO to the applicant in October 2009. The letter included the following paragraph:

… the market value for the subject property should have regard to the physical and legal state of the subject property as reflected at the date of valuation, being 1 July 2000. The valuation is to be completed on a ‘as is basis’ after consideration of all known factors affecting the market valuation as at the date of valuation. It is the value of the interest in the land, improvements, buildings and machinery fixed to the land, and any property rights connected to the interest that were in existence, in the condition, and under the approved zoning that applied as at the valuation date, 1 July 2000.

The Tribunal concluded that a proper reading of the letter from the ATO made it clear that the expression “as is” is a shorthand method of explaining that what was required was the relevant circumstances relating to the land as it existed at the valuation date. The Tribunal also observed that the discounted cash flow methodology is used in valuations of property at a particular date after discounting for risk of uncertain future events – it is forward looking, not backwards looking. The Tribunal concluded the valuer had misapplied the methodology – it was therefore not in accordance with professional standards and did not comply with either Determination.

The Tribunal agreed with the Commissioner that the objection decision made by the Commissioner (applying the agreed value of $9,378,250) was incorrect. The Tribunal accepted the Commissioner’s submission that the margin scheme can only be calculated by reference to an approved valuation. In other words, the Commissioner’s valuation of $8,155,000 must be applied.

The Commissioner submitted that despite the decision of the Commissioner to reduce the penalties from 50% to 25%, the appropriate level in this case was 50% because the applicant’s conduct was reckless. The Tribunal agreed and set aside the Commissioner’s decision to reduce penalties, effectively re-instating the initial penalty of 50%.

On 6 November 2017 Treasury published an Exposure Draft of legislation that will require purchasers of new residential premises and lots in new residential subdivisions to pay an amount equal 1/11th of the purchase price directly to the ATO at or before settlement. The legislation was announced in the 2017-18 Budget and views on the draft are sought by 20 November 2017.

The amendments are intended to address non-compliance by property developers who collect GST at settlement but dissolve the business before lodging the BAS to avoid remitting GST. By making purchasers pay GST directly to the ATO, the main enabler of the evasion activity is removed.

Summary of the proposed amendments

The withholding regime

The amendments will apply to the supply of “new residential premises” (as currently defined in the GST) act and to “potential residential land”, which are essentially lots in a subdivision where the land is zoned residential and that have not previously been sold. This is intended to cover house and land packages where the purchaser may receive a taxable supply of a vacant block of land.

The purchaser must pay to the Commissioner an amount equal to 1/11th of the “price” for the supply and that amount must be paid on or before the day on which any of the consideration for the supply (other than as a deposit) is first provided. This will usually be at settlement, but for a contract payable by instalments, the obligation will be triggered at the time of payment of the first instalment (not being the deposit). The amendments are to be introduced into Schedule 1 of the Taxation Administration Act 1953 as an extension of the withholding provisions in Division 14. These provisions require a payer to withhold part of monies payable to another person in certain circumstances and to pay those amounts to the ATO – for example PAYG withholding.

If the purchaser does not pay the amount to the Commissioner the purchaser will be liable to a penalty equal to the amount payable. However, no penalty will be applied if the amount related to the taxable supply of new residential premises and the purchaser reasonably believed the premises not to be new residential premises.

Where the purchaser pays the amount to the Commissioner, the supplier will be entitled to a credit equal to that amount.

Disclosure obligations on the vendor

Under the amendments a supplier will be prohibited from making a taxable supply of “residential premises” or “potential residential land” to another entity unless, at last 14 days before making the supply, the supplier gives to the other entity a written notice including:

Whether the other entity will be required to make a payment under the amendments in relation to the supply.

If so, the amount required to be paid and when the amount is required to be paid.

If the supplier does not give the notice, it is liable to an administrative penalty of 100 penalty units (a penalty unit is currently $210).

Importantly, a notice will need to be given each time residential premises are supplied as a taxable supply – not just where the supply falls within the amendments. This is to assist purchasers to comply with the legislation.

Sales made under the margin scheme and where the purchaser withholds in error

Where the margin scheme is applied to the sale, the GST payable by the supplier will be less than 1/11th of the price but the purchaser will still be required to withhold 1/11th of the price at settlement and pay that amount to the Commissioner.

To address the cash flow difficulties that may be imposed on suppliers in these circumstances, the amendments provide for a refund mechanism whereby a supplier who accounts on quarterly tax periods and is making sales under the margin scheme can apply for a refund of the difference between the payment made by the purchase and the anticipated GST payable on the supply.

A supplier may also apply for a refund where the purchaser withholds 1/11th of the price in error.

In both cases, the application for refund must be made at least 14 days before the end of the tax period to which the taxable supply is attributed. The Commissioner must refund the amount if would be fair and reasonable to do so, having regard to the matters set out in the statute.

Proposed commencement of the amendments

The amendments are to apply to supplies on which any of the consideration (other than the deposit) is first provided on or after 1 July 2018, regardless of the date of the contract of the sale. However, if the contract was entered into before 1 July 2018, the amendments do not apply if consideration (other than the deposit) is first provided before 1 July 2020.

In MSAUS Pty Ltd as Trustee for the Melissa Trust and Commissioner of Taxation [2017] AATA 1408 the Tribunal handed down yet another GST decision flowing out of the development of the Sebel Manly Beach Hotel by South Steyne Pty Ltd. The stream of litigation culminated in the High Court decision in Commissioner of Taxation v MBI Properties Pty Ltd[2014] HCA 49, where the High Court found that the purchasers of apartments in the complex who acquired the apartments as GST-free going concerns were liable to an increasing adjustment under Division 135 of the GST Act.

The issue in this case was whether the supply was a GST-free supply of a going concern. The taxpayer contended that pursuant to the terms of the contract, the sale was not a GST-fee supply of a going concern but was a taxable supply for which the parties had agreed to apply the margin scheme. The Tribunal agreed.

The decision provides an interesting insight into the construction of contracts. The heart of the issue was not whether the sale could have been a sale of a going concern, but whether the parties had actually agreed that this would be the case.

To add further complexity to the case, the Tribunal observed that the taxpayers were effectively re-agitating questions dealt with by the Full Federal Court in South Steyne Hotel Pty Ltd v Federal Commissioner of Taxation(2009) 180 FCR 409 (South Steyne Hotel) and by the Tribunal in The Hotel Apartment Purchaser and Commissioner of Taxation[2013] AATA 567 (The Hotel Apartment Purchaser) in relation to other purchasers in the same complex – the contractual provisions in those cases were effectively identical. The taxpayers contended that the earlier decisions were not determinative of the outcome because the High Court’s decision in MBI Properties changed the game, or because these taxpayers had addressed gaps that were identified in the arguments in the earlier cases.

At a superficial level, the taxpayers appeared to face a difficult task. The contract was a “tick the box” contract. Against the statement “GST: Taxable supply”, the parties checked the ‘No’ box. They also checked the ‘yes’ box indicating the purchase was “GST-free because the sale is the supply of a going concern under section 38-325”. Further, the parties checked the ‘No’ box alongside the statement “Margin scheme will be used in making the taxable supply”.

The Commissioner contended that these matters disposed of the issue – the parties had agreed in writing that the sale was GST-free as a going concern.

The taxpayer relied on the special conditions in the Contract. Clause 47.6.3 repeated and recorded the parties’ agreement “…that the sale of the Property comprises a supply of a going concern for the purposes of section 38-325 of the GST Act”. The Tribunal observed that this clause tended to reinforce the Commissioner’s argument. However, the taxpayer contended that clause 47.6.6 changed things. That clause read as follows:

47.6.6 if page 1 of the Contract says that the supply is GST-free because the sale is the supply of the going concern but the supply of the Property under the Apartment Lease is a supply of residential premises (but not commercial residential premises), and the premises are also to be used predominantly for residential accommodation (regardless of the term of the occupation), then the sale of the Property is a taxable supply and the parties agree that the margin scheme applies or, if completion has already occurred, the margin scheme is taken to have applied. For the avoidance of doubt, the Vendor acknowledges that if the margin scheme applies to the sale of the Property, the price is inclusive of any GST: MSAUS T-documents at T6-95.

The applicant led evidence from both parties as to the intention of this special condition. The Tribunal observed that a problem with this evidence was that the parol evidence rule makes clear that evidence of pre-contractual negotiations should not be used to inform the interpretation of the meaning of the contract. The Tribunal set aside that evidence and focused on the interpretation of the contract as it was drafted.

The Commissioner relied on the decision of the Full Federal Court in South Steyne Hotel. In that case, the Full Court considered identical provisions in a contract involving another purchaser in the same hotel complex. Emmett and Finn JJ concluded there was an agreement (effectively a complete agreement) in writing within the meaning of s 38-325. The plurality was not persuaded clause 47.6.6 effectively qualified the other provisions of the contract. The Tribunal noted that the plurality’s reasoning was subsequently adopted by the Tribunal in The Hotel Apartment Purchaser at [52]-[58] per DP Frost. Nevertheless, the taxpayer contended that the Tribunal was not obliged to follow the reasoning in South Steyne Hotel in light of the High Court’s conclusion in MBI Properties. The Tribunal agreed.

The taxpayer contended that the decision of the High Court in MBI Properties provided a belated explanation of the risk that the taxpayer sought to avoid by agreeing to a clause such as clause 47.6.6. The taxpayer acknowledged that there were shortcomings in the drafting of the clause, but said that the lawyers were trying to draft a clause that anticipated the risk of events that did not take final shape until the High Court made its decision in MBI Properties. The Tribunal was satisfied that the clause achieved this purpose – the clause as drafted was tolerably clear on its face and it provided for a contingency plan that was activated if something happened that triggered a liability to pay GST. In that event, the parties agreed the margin scheme would apply. Further, the the conditional agreement in clause 47.6.6 to apply the margin scheme was an agreement made on or before the making of the supply. The fact the contingency was not activated until a later event was beside the point: the clause embodying this aspect of the agreement was in place ‘on or before the making of the supply’ .

In conclusion, the Tribunal observed that the reasoning of the High Court in MBI Properties made the purpose of clause 47.6.6 apparent in hindsight. For all of its awkwardness of drafting, the clause turned out to be the produce of “prescient lawyering”.

The taxpayer also sought to rely on a Deed of Rectification entered into by the parties. The Tribunal did not need to address that issue.

In GH1 Pty Ltd, in Liquidation and Commissioner of Taxation [2017] AATA 1063 the Tribunal found that the Applicant was not entitled to input tax credits in respect of creditable acquisitions purportedly made in the course of the development of land in Western Australia. The Tribunal agreed with the Commissioner that the Applicant did not establish that the applicant received taxable supplies. The decision illustrates that the existence of a tax invoice is, in of itself, insufficient to establish an entitlement to input tax credits.

The Applicant carried on a business of managing, financing and constructing land developments in Western Australia. In 2007 the Applicant entered into contracts with MNWA for the provision of bulk earthwork services for two property developments, referred to as “Stage 5” and “Stage 6”. The Applicant lodged an activity statement for the December 2009 quarter claiming credits of $912,216 and for the March 2010 claiming credits of $812,142. The claims included input tax credits for work purportedly performed by MNWA for Stage 5 and Stage 6, invoiced as follows:

11/10/19 – Claim #1 progress payment for Stage 6 – $1,751,181.70;

7/12/09 – Claim #2 on Stage 5 – $2,571,508.32

31/10/010 – Claim #2 on Stage 5, Claim 2 on Stage 6 – $4,659,599.62

The total of the input tax credits claimed was $817,208.15. After conducting an audit, the Commissioner disallowed the Applicant’s entitlement to the input tax credits for these transactions.

At the hearing the Applicant contended that it had met its burden of proof in satisfying the Tribunal that the Applicant was entitled to claim the credits. Further, the Applicant contended as follows:

the Commissioner bore an evidentiary onus in respect of any allegation that the transactions underlying the tax invoices did not occur; and

to the extent that the Tribunal needed further proof, the transactions had been reported consistently in the books and records of the Applicant and MNWA.

At the hearing the Commissioner contended that the the Applicant’s entitlement to input tax credits was correctly disallowed because:

the purported invoices do not evidence any actual supplies made by MNWA to the Applicant;

evidence from various sources, including third parties, showed that all development works for Stages 5 and 6 was completed prior to the dates of the purported invoices; and

the Applicant already claimed the credits in its BAS for the September 2009 and December 2008 quarters.

The Tribunal agreed with the Commissioner. The Tribunal also found that the Commissioner did not bear any evidentiary onus in respect of an allegation that the transactions underlying the tax invoices did not occur. The Tribunal observed as follows (at [42]-[44]):

42. As submitted by the Commissioner:

…if the applicant had led credible evidence to establish that the acquisitions took place, the Commissioner would need to then point to evidence which supported his view that they did not, and in doing so, he would assume an evidentiary onus: Richard Walter Pty Ltd v Commissioner of Taxation (1996) 67 FCR 342. But in the evidentiary lacuna presented to the Tribunal by this applicant, that position never arises because the highest point that the applicant’s case rose to was a submission, in effect, that because the acquisitions were recorded in the MYOB accounts of the applicant, they must have occurred…

43. On the evidence before it, the Tribunal finds that the purposes “tax invoices” do not evidence any taxable supplies made by MNWA to GH1. The mere existence of a “tax invoice” is not, by itself, sufficient to establish that a “taxable supply” (under s 9-5 of the GST Act) and corresponding “creditable acquisition” (under s 11-5 of the GST Act), has, in fact, occurred.

…the reality is that a tax invoice does not create a taxable supply; it records one. If a taxable supply did not take place, then a “tax invoice” is meaningless. In other words, documents that are so called “tax invoices” cannot substantiate a creditable acquisition, if in fact there was no supply or acquisition. It must follow that the scrutiny of transactions is always essential, particularly transactions between related parties.

Having regards to the reference of DP Frost to transactions between related parties, it should be noted that the sole director of the Applicant was in a de facto relationship with the sole director of MNWA.

A particular difficulty for the Applicant in this matter was that no evidence was led from any witness to explain the underlying transactions to the Tribunal. The Tribunal considered that evidence as to the transactions to which the tax invoices and the financial accounts purport to record should was been led by the Applicant. The Tribunal therefore placed no weight on the accounts of the Applicant that recorded the transactions.

The Federal Court agreed with the Tribunal that where the Commissioner contends that particular business structures and transactions were shams, the onus remains on the taxpayer to prove the assessments to be excessive. The Federal Court found that the positions as stated by Lockhart J in Richard Walter Pty Ltd v Commissioner of Taxation (1996) 67 FCR 243 at 245-246:

Use of the word “sham”, in some cases, and this is indeed one of them, obscures the fundamental issue between the parties. Essentially, it is for the taxpayer to prove that an assessment is excessive: …. The onus of proving that the assessment is excessive lies upon the taxpayer; although the evidentiary onus in a particular case may shift from time to time. In this case, the appellant has the burden of establishing that the alleged loans to it by Morlea are not income. It is common ground that if this burden is discharged and it is established that the payments here are in fact loans, then the appellant will succeed, provided it survives the possible application of s 260.I mention this because it is a misconception in my view to assert that the Commissioner has the burden of establishing that a transaction is a sham. The Commissioner may, as he did in this case, submit that the relevant transactions were a sham and of no force or effect. In some cases the evidentiary onus may shift to the Commissioner to establish what the real transaction is for which the sham transaction is a cloak (assuming there is a real transaction); but at most this is an evidentiary onus which may shift back and forth depending upon the facts of the case and inferences which it is proper for the Court to draw. It remains that the burden of proving that an assessment is excessive lies upon the taxpayer.[Footnote references omitted]

The facts and the decision by the Tribunal

An individual had for a number of years operated a business of supplying casual labour to meet the seasonal demands of orchardists and vignerons. Until 2011 he operated through a company which contracted with growers to provide casual labour. The company was paid by the growers and it paid wages to the employees, deducted PAYG and paid payroll tax. In June 2011, the method changed and the applicant was incorporated to act as a trustee of a discretionary trust. Under the new arrangement, the applicant provided casual labour to growers, but it was said to be done through a succession of contracts with other companies, with those companies being obliged to account for PAYG deductions and payroll tax of the workers if necessary.

After an audit, the Commissioner concluded that the arrangements with the other companies were a sham and disallowed input tax credits claimed by the applicant on supplies said to be made to it by the other companies. The Commissioner also disallowed income tax deductions claimed by the applicant.

At the hearing, the applicant contended that where the Commissioner alleges a sham, the onus falls on him to prove the charge. The Tribunal did not agree. Rather, as the Commissioner alleged that the arrangements between the applicant and the other companies were not as they appeared to be, it was for the applicant to show that the assessments were excessive and that the arrangements were genuine and real.

The Tribunal considered that the applicant had failed to discharge that onus, largely because the applicant failed to adduce evidence from the persons said to be centrally involved in the new arrangements.

The Appeal

The Federal Court observed that the Tribunal was correct to take as his touchstone for the concept of sham transactions the following statement of Mustill LJ in Hadijiloucas v Crean [298] 1 WLR 1006 at 1019 which, subject to one qualification, was referred with approval by Gleeson CJ, Gummow and Crennan J in Raftland Pty Ltd v Commissioner of Taxation [2008] HCA 21 at [35]:

… it is necessary to distinguish between three situations in which, aside from any question of rectification, the court may take an agreement otherwise than at its face value. The first exists where the surrounding circumstances show that the arrangement between the parties was never intended to create any legally enforceable obligation. The second is the case of the “sham,” in the sense in which that word has been used in numerous cases, including Snook v London and West Riding Investments Ltd. Correctly employed, this term denotes an agreement or series of agreements which are deliberately framed with the object of deceiving third parties as to the true nature and effect of the legal relations between the parties. The third situation is one in which the document does precisely reflect the true agreement between the parties, but where the language of the document (and in particular its title or description) superficially indicates that it falls into one legal category, whereas when properly analysed in the light of the surrounding circumstances it can be seen to fall into another.[Footnote reference omitted]

The qualification made in Raftland was that any absence of intention to create legal relations need not necessarily entail fraud.

The Tribunal found that the present matter fell into the first of these categories. The Federal Court found that there were, to say the least, logical and legally permissible bases for the Tribunal’s conclusion. The Federal Court found that the the Tribunal’s reasons were thorough, methodical, relentlessly logical, well grounded in legal principle both as to the operation of the onus of proof and the doctrine of sham and amply explain why the objection decisions were confirmed. The Federal Court concluded that, in design, the structure looked to be but a crude, interposed company of no worth, run by a straw man (a feature reminiscent of the “bottom of the harbour” behaviour of a generation ago) with “phoenix” successors. The taxpayer also failed to show that the key legal elements of the structure were ever intended to take effect.

The taxpayer contended that the option fee was provided to obtain an interest in the real property. Further, the Deed of Option stated that the option fee was paid as partial consideration for the property and it was an express them of the Deed of Option that the purchase price was $28m.

The Tribunal agreed with the contention of the Commissioner that there were two separate supplies under the GST Act, the supply of the option (a bundle of rights) from the owner to the taxpayer for consideration of $2m and the supply of the land for consideration of $26m. The Tribunal agreed with the construction adopted by the Commissioner in GSTD 2014/2, being that the supply of an option is a separate supply to the supply of the underlying asset.

The Tribunal agreed with the Commissioner that a plain reading of s 9-17 of the GST Act makes it clear that when there is an option fee paid, the consideration for the supply of the freehold interest in land is limited to the consideration paid in addition to any option fee. The Tribunal also concluded that the fact that the Option Fee provided that the $2m option fee “forms part of the Purchase Price” and that the “Purchase Price” was stated to be $28,000,000 (inclusive of the Option Fee)” was of no moment. The drafting of the Option Deed did not defeat what was occurring, in substance and for the purposes of the GST Act. The taxpayer could not effectively “contract out” of what, as a matter of fact and law, happened.

In December 2015 the UK First Tier Tribunal handed down its decision in Adecco Uk Ltd v Revenue & Customs [2015] UKFTT 600 – a case that illustrated the difficulties with tripartite agreements both in Australia and in the UK. The Tribunal had to decide whether Adecco was liable to pay VAT on the full charge paid by its clients for the services of non-employed temps provided by Adecco to those clients or only on the element of the charge retained by it (i.e. the commission or gross profit element). At issue was whether Adecco supplied the temps to its clients or only the service of introducing the temps.

My post discussing the decision of the First Tier Tribunal can be accessed here. That decision was also discussed in a paper I presented on tripartite arrangements in February 2016 – my paper can be accessed here.

On Friday 17 March 2017 the Upper Tax Tribunal handed down its decision on the appeal of the decision in Adecco and another decision relating to VAT and tripartite arrangements. In each decision the Tribunal (constituted by the same members) dismissed the taxpayer’s appeal and relied heavily on the decision of the UK Supreme Court in Airtours Holiday Transport Ltd v HMRC [2016] UKSC 21 and the principles outlined in that case (my post on the Airtours decision can be accessed here)

In dismissing the appeal, the Tribunal observed that its task was made easier by the judgment of Lord Neuberger in Airtours which contained an analysis of the principles to be derived from previous decisions. The decision of the Supreme Court was handed down after the decision of the First Tier Tribunal, so the primary judge did not have the assistance of that case.

The Tribunal (at [43]) stated that it was clear from Airtours that determining the nature of a supply, and who is making and receiving it, is a two-stage process. The Tribunal observed as follows:

The starting point is to consider the contractual position and then consider whether the contractual analysis reflects the economic reality of the transaction. If, as a matter of contact, a party undertakes to provide services to another person in return for consideration from the other or a third party then there is, subject to the question of economic reality, a supply to the other person for VAT purposes. If the person who provides the consideration is not entitled under the contractual documentation to receive any services from the supplier then, unless the documentation does not reflect the economic reality, there is no supply to the payer. The contractual position normally reflects the economic reality of the transactions but will not do so where, in particular, the contractual terms constitute a purely artificial arrangement.

In applying these principles, the Upper Tribunal made the following findings:

there were contracts between the non-employed temps and Adecco and between Adecco and its clients – there was no contract between a non-employed temp and the client. The temps agreed to perform each assignment in return for payment by Adecco at an agreed hourly rate. There was nothing artificial about the agreements

the Upper Tribunal did not accept the argument that the fact that Adecco did not receive and use or consume the services provided by the temps leads to the conclusion that Adecco cannot make a supply of the temps to the clients

the economic and commercial reality of the transactions was that Adecco agreed to provide temps, who would carry out work, to the clients – what Adecco was supplying was the provision of a temp to perform an assignment

In a final observation, the Upper Tribunal stated that it hoped that the decision provided some clarification on the VAT obligations of employment bureaux but doubted that it provided guidance – except at a very high level – that will enable the VAT liability of other employment businesses to be determined without a thorough analysis of the contracts and an assessment of the economic reality of particular transactions. That liability will depend on the construction of the contractual provisions and the interpretation of the facts – matters which are always open to debate – and as Lord Reed said in paragraph 26 of WHA [WHA Limited v Her Majesty’s Revenue and Customs [2013] UKSC 24]:

…the decisions about the application of the VAT system are highly dependant upon the factual situations involved. A small modification of the facts can render the legal solution in one case inapplicable to another.

U-Drive Limited v Revenue & Customs [2017] UKUT 112

In U-Drive Limited v Revenue & Customs [2017] UKUT 112 the Upper Tribunal dismissed the taxpayer’s appeal of the decision of the First Tier Tribunal in U-Drive Ltd v Revenue & Customs [2015] UKFTT 667. The taxpayer (a car hire company) arranged for the repair of third party vehicles damaged in collisions with hired cars as an alternative to a claim being made through the third party’s insurance in which case the claim would ultimately be paid by the taxpayer’s self-insurance arrangement. There was no contract between the third party car owner and the repairer and the repairer invoiced the taxpayer for the repairs, which it paid. The taxpayer claimed that it was entitled to recover the VAT on those invoices.

The issue was whether the supplies made by the car repairers were made to the taxpayer or to the third party owners.

The Tribunal reviewed the previous decisions and expressed the same view as in the Adecco appeal, that it was clear from Airtours that determining who is receiving a supply is a two-stage process. The Tribunal (at [38]) outlined similar principles to those outlined in Adecco (at [43]) and extracted above.

Applying these principles to the facts, the Upper Tribunal made the following findings:

it was found by the First Tier Tribunal that there was a contract between the taxpayer and each repairer which the repairer agreed to repair the third party owner’s vehicle and, in return, the taxpayer agreed to pay the repairer for the repair. There was no contract (and often no contact) between the third party owner and the repairer and no contract between the taxpayer and the car owner.

viewed in isolation, the contracts between the taxpayer and the repairers show that there was a legal relationship between the repairers and the taxpayer pursuant to which there was a reciprocal performance and thus that the repairers supplied services to the taxpayer

it was common ground that the contracts were not artificial, but that did not mean that the economic reality of the transactions should not be considered – the Tribunal made the following findings on the economic reality of the transactions:

the taxpayer agreed to pay for the repair of the third party owner in order to discharge the liability of the taxpayer’s insurer to indemnify the hirer for the liability to compensate the third party owner for damage to the vehicle

the taxpayer did not have any liability to pay for the repair until after the damage had occurred and the third party owner had agreed to use the alternate procedure rather than make an insurance claim

the taxpayer agreed to pay for the repairs because it calculated that, by doing so, it would ultimately pay less than if the third party owner made a claim through his or her insurer

taking account of all the circumstances, in economic reality, the taxpayer simply agreed to pay for the repair of the third party owner’s vehicle – the taxpayer had no interest in the repairs other than as a means to meet (at reduced cost), a liability that would be incurred through its own insurer (and ultimately the taxpayer through the fact that the premiums were set by references to the claims made – which was in effect, self-insurance).

Comment

The decisions illustrate that when characterising the supply (or supplies) made under a tripartite agreement, or indeed any agreement, the first step is generally to analyse the contractual arrangements between the parties. That will often give you the answer – as it did in Adecco. However, that will not always be the case. In some cases a consideration of the economic reality may give you a different answer – as it did in U-Drive.

The terms and conditions are the instrumentality through which the supply is made, but the text of these terms and conditions is not conclusive of the character of the supply that is made; that will depend as much on the manner of performance of those terms and conditions as the text of the terms and conditions themselves; it will also depend on the commercial or business purposes, discerned objectively, of those who have entered into the relevant contract.

In Eastwin Trade Pty Ltd and Commissioner of Taxation [2017] AATA 140 the Tribunal found that the taxpayer did not discharge its onus of showing that it was entitled to input tax credits for the purchase of “scrap gold” from suppliers. The taxpayer held tax invoices that were said to record the transactions, but the primary issue before the Tribunal was whether the asserted purchases of gold were real transactions and if so, what was purchased and from who – the Tribunal observing that reality was not sufficiently established by the invoices themselves or by the taxpayer’s accounting records.

The purchases and sales of gold by the taxpayer were said to operate as follows:

the seller would contact the taxpayer about a delivery of gold in “dore” (taxable) form and the taxpayer would contact potential buyers

the taxpayer would take delivery of the gold and would lock in the price when buyers came to pick up the gold

the taxpayer would remit payment to the supplier and would receive a purchase invoice from the supplier a few days later

the gold was delivered to the taxpayer at night, in car parks

The taxpayer relied on tax invoices dated 13 January 2014 to 25 September 2014 purportedly evidencing expenditure of $143.3m on the purchase of about three tonnes of gold dore and invoices dated 8 January 2014 to 26 September 2014 purportedly evidencing total sales of $143.9m of a similar quantity of gold dore.

The principle matters relied on by the Commissioner in the objection decision were as follows:

inconsistent supply information – during interviews with the taxpayer in July and August 2014 the taxpayer had identified one entity as its only supplier (first supplier), but only provided information about another supplier (second supplier) after being told that the initial supplier had been incorporated in April 2014.

incorrect or cancelled ABN – the ABN on invoices from the second supplier was that of an apparently unrelated entity, and that had been cancelled on 28 April 2014. The ABN of the first supplier was cancelled in September 2014 with effect from 1 April 2014.

no GST registration – neither of the suppliers were registered for GST

unrelated payments/absence of consideration – all payments contended to have been made by the taxpayer were to a bank account of a company with no demonstrable connection with either supplier

uncorroborated supply – the taxpayer could not provide any contact details for whether supplier – that inability, the “car park” mode of delivery for three tonnes of gold, and the payments to an unrelated recipient, led to an absence of satisfaction that any of the suppliers had in fact supplied the invoiced items to the taxpayer.

no basis to treat documents as a tax invoice – in the absence of satisfaction that a “creditable supply” had in fact occurred there was no basis to exercise the discretion conferred by s 29-70(1B) of the GST Act.

The Tribunal observed that there was objective evidence that the taxpayer had sold gold dore and that this fact was at least consistent with the taxpayer also having purchased gold dore. However, this in itself was not relevantly probative of dore purchases. The Commissioner also made the following contentions:

the taxpayer’s sales invoicing practices, with their precise statement of gold content, and absence of complaint from customers, indicated an actual gold content knowledge that could only have been possessed by someone who had created the dore bars from bullion;

there were practicable means, and a significant commercial incentive, for a person to engage in a practice of purchasing gold bullion and smelting it into dore;

the taxpayer’s dore bars had a physical appearance consistent with such an operation having been carried out; and

the taxpayer’s various transaction records tended to establish the likelihood that it had possession of the gold for long enough to have undertaken such a smelting process.

The Tribunal observed that the Commissioner’s hypothesis about the commercial motivation to purchase bullion – in a disguised transaction – and then convert it to dore, involved two main assumptions. The first assumption was that the dore is saleable at a GST inclusive price less than 110% of the “spot price” for fine gold. The second assumption was that the disguised transaction involved a bullion purchase being dishonestly presented as a taxable supply, and either the GST component of the sale not reported (by the vendor), or made the subject of a false claim for input tax credits (by the purchaser). Once that assumption was made, the Commissioner’s submissions explained how the smelting of bullion, and its subsequent sale as a taxable supply, could provide a significant commercial benefit to the seller.

The Tribunal noted that the Commissioner’s contention was a hypothesis and there was no direct evidence that the taxpayer carried out any bullion conversion activities and the Tribunal accepted that the taxpayer was right to emphasise the absence of evidence tending to establish its participation in the purchase, and subsequent “conversion”, of bullion. Nevertheless, the Tribunal found that the critical matter that the taxpayer had to establish was what it did in fact acquire.

The Tribunal concluded (at [92]) (after a detailed analysis of the oral and documentary evidence) that they taxpayer had failed to establish the identity and reality of any “supplier” entity. Given this finding, the Tribunal concluded as follows:

My view is that meaningful conclusions about the detailed “registration”, “enterprise” and “consideration” contentions could not be reached where the evidence merely points to the fact of some kind of acquisition, but is devoid of any credible details about the identity and reality of the “supplier” and that entity’s circumstances and activities.

Comment

The central issue in this case was whether the taxpayer actually made creditable acquisitions of gold dore – i.e., whether the transactions were real. The approach of the Tribunal to this issue was outlined at [24]:

Eastwin’s submissions accepted that the evidentiary onus imposed on it by TAA 53 s 14ZZK required it to establish, on the balance of probabilities, that its asserted purchases and sales of gold dore were real transactions. That reality is not sufficiently established either by the invoices themselves:- see Bayconnection Property Developments Pty Ltd and Commissioner of Taxation [2013] AATA 40; (2013) 90 ATR 488 at [86] and RV Investments (Aust) Pty Ltd as Trustee for the RV Unit Trust and Commissioner of Taxation [2014] AATA 158; (2014) 94 ATR 670 at [72]; or by a taxpayer’s accounting records:- Richard Walter Pty Ltd v Commissioner of Taxation (1996) 67 FCR 243 at 247 per Lockhart J. Nevertheless, invoices may provide part of the evidence establishing the reality of the underlying transaction, and Eastwin relied on them. This involved Eastwin in grappling with two main factual questions – (i) who was its supplier, and (ii) what was delivered to it.

In this case, the taxpayer actually did sell gold dore. A clear inference is that it must have also purchased gold. The difficulty for the taxpayer was that it could not positively show who it bought the gold from and what it actually bought – in particular whether it bought the gold in dore form (taxable) or as bullion (non-taxable).

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